Decision-Making for Traders

A primer on using higher-order reason, not your 'rat brain'

Trading and investing are all about making decisions. Markets move because millions of people are making decisions, and millions of people are making decisions because markets move. Volatility is the result of millions of people making millions of decisions every day.

Decision-making in the financial markets is compounded in difficulty by the fact that the markets are a complex adaptive system. They aren’t entirely random because strong emotions create trends. But they aren’t entirely efficient because too many people are making decisions based on poorly conceived opinions.

When we add the media, breaking news, e-mails that come hurtling onto our screens during trading hours, the financial wire services and the slew of rumors and deceptions, it’s clear that sorting out and filtering can be totally overwhelming.

The brain uses two major systems to make decisions. One of them is well-known to veteran subscribers of any of my services: the “rat brain” deep inside the middle section of the brain. It’s a primitive brain that uses extremely rapid processing. This part of the brain acts on instincts, hunches, tips and anything that looks like a hot deal now. The rat brain is primed for instant gratification and runs on the chemical called dopamine.

Dopamine floods through the rat brain when it encounters an instant reward. If Las Vegas is a dopamine paradise, then its gaming parlors are a dopamine bathtub, since the flashing lights, clanking money and showgirls are deliberately set up to prime you to go for all you can get. The rat brain kicks into high gear — a dangerous situation, since it doesn’t think logically, and it makes up its mind quickly.

The other brain area involved in decision-making is quite different from the rat brain. This is the “new brain” that evolved over the rat brain as the cerebral cortex developed. It’s the logical, rational, thinking part of the brain. It acts slowly in a calm and reasoned manner. It has the ability to contemplate itself. When it looks at what the rat brain did — for example, using hard-earned money to play a “hot tip” — it considers that to be plain crazy.

The new brain is bombarded constantly by the rat brain’s need for instant gratification. Just as traders are waging war with each other every trading day, the brain inside each trader is waging war with itself.

With the massive amounts of information that bombards traders in the course of a day and without a clear trading strategy and plan, the rat brain wins because it’s the default neurobehavioral system for decision-making. Thus, when you’re under the influence of stress, confusion, anxiety, fear, greed or uncertainty, the rat brain will always make the decision because the new brain isn’t able to act rapidly enough.

Seriously, try to get a grip on your brain and behavior during market hours because the days of lower volatility and a market that seems to move in an orderly fashion are all fixin’ to change over the coming weeks and months.

Now is the time to get your emotions under control because we’ll be entering a market where, if you don’t recognize this behavior now, it will be the difference between banking fat profits and losing them.

John Lansing tracks the charts all day and offers expert technical analysis in his day-trading, options and trading services: Power Trading at the Open, Parabolic Options and Trending123.